November 20, 2009
One key point associated with a Cap & Trade scheme is that concerned corporations are actually in a position to trade their granted envelope of allowances on specialized climate exchanges (Bluenext or ECX). Obviously, this is what happens in most cases, leading to some bearish pressure on the ETS spot valuation, mostly at the beginning of the review period. Now, since those allowances will need to be bought back again at the end of the review period – in order to remain within the cap – corporate treasurers mainly go for a hedging on the ETS future markets. Well, this makes certainly sense, albeit it could be less interesting from the tax perspective since selling an asset that one received for free just translates into as much realized profit. And although there will be a repurchase in the future, the two operations are not linked. The strange thing about this is that EU allowances are actually equivalent to a commodity (tCO2e). And looking at more mature commodity markets, a complete range of structured ownership operations have been devised in order to meet the demand of hedgers and investors. Take for instance the well known ‘Repurchase agreement’ (Repo): usually a transaction where a seller of an exchange quoted asset (bond, commodity) immediately agrees to buy-back said asset on an agreed date in the future, at a price determined by the cost of carry on the period for the buyer (equivalent to an interest rate). This type of transaction bears a lot of advantages for both parties; for one it constitutes an easy way for the selling party to ‘borrow’ cash against a natural guaranty (the asset), hence at a lower rate. On the tax side as well, as the Repo is considered a two-legged single transaction, the taxation normally only applies on the differential between the selling and buying-back prices (or the interest), which of course represent a much lower amount.
Now for commodities and aside Repo’s there are plenty of other possibilities, like Cash and Carry transactions or Total return Swaps for instance. And although those are quite common stuff for others commodities, it seems banks are still reluctant to develop such a market for carbon allowances and/or credits right now, despite all conditions being reunited. Something to expect in a near future?Author : Bruno Simon